WASHINGTON — The federal banking agencies in coordination with state regulators released guidance Wednesday that offers a clearer picture of how they will supervise the use of new benchmarks in place of the London interbank offered rate.
In an interagency statement, the regulators said banks must conduct the "due diligence necessary" to ensure that whichever benchmark they choose to replace Libor is appropriate for their firm’s risk profile and products.
Although the Alternative Reference Rates Committee — a U.S. group of market participants convened by the Federal Reserve — recommended the Secured Overnight Financing Rate to replace Libor, the banking agencies have said firms are free to choose a substitute benchmark that meets their needs.
That could include Ameribor or the Bloomberg Short-Term Bank Yield Index. Still, the ARRC has maintained that financial institutions should adopt SOFR.
“As part of their due diligence, supervised institutions should understand how their chosen reference rate is constructed and be aware of any fragilities associated with that rate and the markets that underlie it,” the regulators said in the interagency guidance published Wednesday. They included the Fed, Federal Deposit Insurance Corp., Office of the Comptroller of the Currency, National Credit Union Administration and Consumer Financial Protection Bureau.
Regulators
A new Libor contract would mean any contract that creates additional Libor exposure or extends the term of an existing Libor contract, the agencies said.
“Additionally, considering the narrowing timeline involved, contracts entered into on or before December 31, 2021, should either use a reference rate other than Libor or have fallback language that provides for use of a strong and clearly defined alternative reference rate after Libor’s discontinuation,” the guidance said.
On Monday, the OCC went a bit further in its guidance, telling banks that they can use any rates they determine are appropriate, but that "supervisory efforts will initially focus on non SOFR rates."
The agency also laid out several principles for selecting a new reference rate, including that the replacement rate should have extensive underlying historical data and should reflect the “competitive forces of supply and demand.”
